The European Central Bank (ECB) has pushed up interest rates for the seventh time in less than a year, the fastest pace of increase in its history. The decision to increase by a quarter point this time – as opposed to a half point – was an uneasy compromise on the ECB board, where some members wanted a half point rise. For many borrowers, the scale of the increases is a significant additional financial burden in the middle of a cost-of-living crisis. And there will likely be more to come, with ECB president Christine Lagarde saying the bank still has “more ground to cover.”
What happens next will depend on inflationary trends. Price pressures have eased significantly, but the headline inflation rate is still way above the ECB’s 2 per cent target level. More hawkish members of the governing council want to see interest rates increased significantly more and a decision to cut the ECB’s holding of government bonds further looked like a move to get them to sign up for a rise of just a quarter point this time.
The difficulty for the ECB is that it takes significant time for interest rate rises to have an impact on consumer demand and business spending and thus on inflation. Clearly interest rates needed to increase over the past year, but there is a significant risk now of going too far, too fast.
The ECB’s mandate is purely focused on inflation, but it will realise that if higher interest rates are responsible for sending the euro zone into recession, it will have gone too far. Pressures on the banking sector are further reason for caution.
Also, the ECB policy to control inflation is hitting a particular group of people – those on variable mortgage rates and particularly trackers – hard. Its argument is that it is worth taking some pain now to ensure that inflation does not take hold. But there is a case for the ECB to hold off now for a period to see the impact of what it has done so far.
Higher mortgage rates also create a dilemma for the Government, under political pressure to help those affected. Sinn Féin has called for mortgage tax relief aimed at those worst affected. There is certainly a case to ensure that people can switch mortgages as easily as possible and for some special measures for those whose loans are now owned by international funds, some of whom are being charged interest rates of more than 8 per cent. The promises these people got from Government and regulators when their loans were sold are not counting for much.
On the question of wider relief, the Government needs to proceed carefully. There are difficult fairness issues in picking out particular groups of borrowers to be helped. And if mortgage interest relief is extended to all borrowers this would risk wasting a lot of public money, helping many people who do not need assistance and also adding to inflationary pressures.